Buffett Indicator: What is it and how to use it as an investor
The Buffett Indicator is a macroeconomic indicator that compares the total market capitalization of all public companies to the gross domestic product (GDP) of a country. This ratio is used to assess whether the stock market is overheated and whether a bubble is likely to occur.
Warren Buffett himself called this indicator “the best overall market indicator” because it reflects the ratio of stock prices to the real size of the economy.
How to interpret the indicator values?
High (> 100%)
If the indicator exceeds 100%, it means that the stock market is worth more than the country's economy.
If it rises above 150-200%, as in 1999 before the dot-com crash, it may signal overheating and a high probability of a crash.
In 2021, the Buffett indicator for the US reached a record 230%, which indicated that stocks are strongly overvalued.
Low (< 100%)
If the indicator is below 100%, it may mean that stocks are undervalued relative to the economy.
In times of crisis, the indicator can fall to 50-70%, creating favorable opportunities for long-term investors.
Historical examples of using the Buffett indicator
1999 (dot-com crash) — The indicator rose above 150%, which foreshadowed a strong market correction in 2000-2002.
2008 (global financial crisis) — Before the crisis, the indicator was above 100%, and during the crisis, it fell below 60%. This gave investors the opportunity to buy shares at low prices.
2021 (record market overheating) — The indicator reached 230%, which indicated a possible bubble. In 2022, the market began to correct, and many investors faced losses.
How can an investor use the Buffett indicator?
Determining the stages of the market
High values (> 150%) → the market may be overheated, corrections or a crisis are possible.
Average values (80-120%) → the market is fairly valued.
Low values (< 70%) → the market may be undervalued, a good time to buy.
Strategy Formation
When the indicator is off the charts (> 150–200%), it is reasonable to be cautious with stock investments and consider diversifying into bonds, gold, or other assets.
When the indicator is falling (below 80%), this may be a signal for long-term investments.
Analysis of individual countries
It is important to note that the indicator has its own norms for different economies. For example, for the US, the indicator is often above 100%, and for emerging markets it may be lower.
Conclusion
The Buffett indicator is a powerful tool for assessing the overall state of the market. Although it cannot accurately predict the moment of a collapse, it gives investors an important reference point: whether the stock market is too expensive relative to the economy or, on the contrary, offers profitable investment opportunities.
With the current value of ~210%, investors should be especially careful, since such high levels have been accompanied by market corrections in the past.
